George Osborne was presumably aiming at himself and his friends, when he vowed “to speak truth to power and wealth” at the Tory party conference this week, but dare he speak economic truth to the rest of us? – simultaneously published on Left Foot Forward >

On the narrowest of bases, he might still claim he spoke “truth” to the weak and powerless when in the House of Commons debate on the economy on August 11th he made this challenge:

“Those who spent the whole of the past year telling us to follow the American example, with yet more fiscal stimulus, need to answer this simple question: why has the US economy grown more slowly than the UK economy so far this year?”

It was a ‘brave’ claim when he made it, and it’s looking even ‘braver’ – and more disingenuous – now.

Following very recent revisions to US and UK data on GDP for the first half of 2011, the position is as follows, broken down into different quarters:

UK growth:

Q1    +0.4%   (revised down from the previous +0.5)

Q2    +0.1%   (revised down from the previous +0.2)

Total: +0.5%

US growth:

Q1   +0.1%

Q2   +0.325% (revised up from 0.25%)

Total: +0.425%

So by the triumphant margin of 0.075%, taking the period in total isolation, Osborne just scrapes home. But this ignores the fact the UK quarter 1 figure of +0.4% followed the disastrous Q4 figure of -0.5%, compared to US Q4 growth of more than +0.5%.

Without this Q4 quirk, his tenuous case would collapse.

For when we compare the US and UK over the last three quarters (including Q4 2010), we find that the US grew by 1%, whilst the UK grew not at all. A difference of one per cent in favour of the US economy.

And over the 12 months to the end of June, i.e. the lifespan of the coalition government, the US rate of growth is likewise 1.0% greater than in the UK (US 1.6%, UK 0.6%).

Taking the last 18 months, we get the following medium-term picture:

US:

2010                        +3.0%

2011 first half         +0.4%

18 months               +3.4%

UK:

2010                        +1.4%

2011 first half         +0.5%

18 months               +1.9%

In other words, the US economy has grown by 1.0% more than the UK over the last 12 months, and 1.5% more over the last 18 months, to end June 2011.

The US has many problems, but it has applied some meaningful, if now fading, stimulus.

So if George Osborne really does wish to speak truth, to power and wealth, and to the rest of us, let him own up – it is simply not true the UK’s austerity-based economy has grown faster than the USA’s. On the contrary, coalition government policies have led us deeper and deeper into the mire of unemployment, bankruptcies and economic stagnation.

Wall Street plummeted as concerns over European debt and the US economic downturn spurred a broad sell-off. Photograph: Shen Hong/Xinhua Press/Corbis

Read my article from Guardian Cif, Friday 19th August:

As bank shares and stock markets plummet, and investors flock to the safety of government bonds; as obstinate EU leaders crucify their countries in a futile struggle to defend today’s equivalent of the gold standard; as British and American politicians adopt austerity policies and drive their economies closer to the cliffs of depression; and as most professional economists stand aloof from the escalating crisis – what lies ahead for ordinary punters like you and me?

First, let’s take look at the big political picture. This crisis is already sharpening the divide between left and right in both the EU and the United States. Studying a precedent – the implosion of the 1920s credit bubble in 1929 – we note that four years after that crisis erupted, the political divide sharpened decisively. The United States and Britain moved to the left. Germany chose a different path. After 1930, Germany’s Centre party under Chancellor Brüning adopted austerity policies that resulted in cuts in welfare benefits and wages, while credit was tightened. At the same time the German government engaged in wildly excessive borrowing from the liberalised international capital markets. The ground was laid for the rise of fascism.

Four years after the “debtonation” of August 2007, our political classes in both the EU and the US have consciously declined to restrain out-of-control finance sectors or to fix broken, effectively insolvent banks. Instead, central bankers deployed taxpayer-backed resources (quantitative easing) to finance, guarantee and bail out bankers who then went on a wild, speculative spending spree.

At the same time, politicians imposed austerity on the more socially useful and productive sectors of the economy, both public and private. In both the EU and US these economic strategies have angered the populace and emboldened the right; in particular the far right. Looking ahead through the political lenses of austerity, street rioting and Tea Party obstructionism, the signs are ominous.

And then there is the impact on our own living standards. For comparisons and precedent, we need only look at Japan. Our politicians and central bankers have not learned from Japan’s crisis, which preceded our own. We are, therefore, destined to follow Japan’s disastrous record of lost decades of economic activity. As in Japan, so here: a broken banking system, crushed by the weight of unpayable debts on its balance sheet, fails to lend to businesses at affordable rates. Pretty soon this constrains investment. First-time buyers can’t get affordable loans or overdrafts, placing downward pressure on property prices.

A fall in investment is compounded by government policies for austerity – rises in VAT, and cuts in public spending. These policies trigger a rise in unemployment. Rising unemployment causes people to snap their purses shut, placing even further downward pressure on prices, profits, wages and employment. The downward spiral is then hard to arrest.

Property prices across Japan have continued to slide uninterrupted for nearly two decades. Hard though it may be for us to accept, it is not impossible to imagine UK property prices falling for the next two decades.

Just as here, Japan’s politicians and central bankers exaggerated the risks of inflation, reflecting the concerns of bankers and creditors – who fear inflation will erode the value of their outstanding loans. And so they were slow to a) use monetary policy to help the broader economy recover, and b) to restructure banks. The primary Keynesian tools for reversing the Great Depression were an aggressive monetary policy combined with extensive restructuring of the banking system.

While Keynes is largely defined (by his enemies) as a fiscal activist, he was first and foremost a monetary economist. In other words, he believed that if governments and central bankers would only fix the money system – by lowering rates of interest for all borrowers (not just the banks); by injecting QE into productive, socially useful projects; and by restructuring the banking system – the rest of the economy could be helped to recover.

Because our politicians and central bankers have so firmly rejected these lessons, prospects don’t look good for us at all. Instead, we would do well to echo Frank Zappa’s realism: “I mean to say that every day/Is just another rotten mess/And when it’s gonna change, my friend/Is anybody’s guess.”

Tonight, Wednesday 3 August 2011 at 08.00pm BST (GMT +1), BBC Radio 4 will broadcast a debate which took place at the London School of Economics (LSE) on 26 July.  This broadcast will be repeated on Saturday, 6 August, at 10.15 p.m BST (GMT +1).

Along with my colleagues Prof. Victoria Chick and Douglas Coe at PRIME  we have written the following response to the debate:

Debaters considered whether Keynes or Hayek had the solution to the present financial crisis. The economist George Selgin and philosopher Jamie Whyte spoke for Hayek; Keynes’s biographer Robert Skidelsky and the economist Duncan Weldon spoke for Keynes.

On the one hand we are pleased that the BBC and the LSE now acknowledge rival positions to the present austerity policies of Western governments. On the other  we are concerned that the debate might have served mainly to reinforce existing prejudices, rather than to clarify the substance of the matters under discussion, matters which – there can be no doubt – are of the most profound importance.

Lord Skidelsky provocatively but justly reminded the audience that in the early 1930s, the same orthodoxy driving western austerity policies directed the actions of Germany’s 1931 Bruning government and paved the way for the rise of Nazism. These actions – vigorously opposed by Keynes – were the final straw for a Germany crushed by defeat and the disastrous boom-bust cycle that followed their return to the gold standard. Reparations were easily circumvented by wildly excessive borrowing from financial interests around the world, in a manner that even Keynes did not anticipate. It was these financial and fiscal policies that brought Hitler to power.

With financial interests still firmly in the ascendency and reactionary right-wing forces increasing their grip in the United States and much of the Western world, we must not forget these lessons from history, which formed the background to the original debate between Keynes and Hayek themselves. The stakes are high indeed.

Keynes shared with Hayek a preference for the economy to be primarily the province of the private sector. However, he recognised that ‘the market’ did not always best serve the common good and therefore that state intervention was necessary – and not just during a slump. In this he was diametrically opposed to Hayek.

For Keynes, the market’s major flaws were rooted in monetary arrangements that favoured speculation and excess consumption rather than productive activity. In addition, in a slump, the pessimistic outlook of producers and investors allowed the slump to persist and needed the stimulus of public works expenditure.

The LSE debate neglected the subtleties of the respective positions of Hayek and Keynes and reinforced many of the most common and most dangerous fallacies about Keynes’s contribution – and even established some new ones.  While both economists were misrepresented to some extent, our main concern must be to rectify distortions about Keynes. There are eight misrepresentations that we want to bring out.

1.   Hayek as “an opponent of financial excess”

From 1971 through the early 1980s, restraints on the financial sector were steadily unwound. These actions were prompted by Hayekian ideals of liberalism, as is well known.  The Hayek supporters at the LSE debate dissociated themselves from this liberalisation, the cause as we now know, of the rapid expansion of the money supply before the crash. Hayek might not have predicted this consequence of liberalisation, but its disastrous consequences are now plain to one and all. Perhaps this is why the debaters dissociated themselves from this aspect of Hayek’s position. Instead they castigated the conduct of the liberalisation policy rather than the policy itself. Indeed the ideal of liberalisation was scarcely mentioned, for to do so would be to acknowledge the existence of an alternative: Keynes’s managed financial system.

2.   Keynesian policy as “promoting the big state”

Keynes’s most substantial legacy was a financial system managed by the state.  This system prevailed from the end of the gold standard until the 1970s. This management ensured that on the one hand low long-term interest rates facilitated both private and public sector investment; on the other, restraints on

banks and capital mobility kept speculation and excessive consumption at bay. Keynes had devised and helped implement a financial system that was conducive to production and investment rather than speculation and consumption.  A larger state rightly prevailed than in the 1920s or 1930s, but ironically Keynes’s state was still smaller than the state that prevailed after the counter-revolution of financial liberalisation

The post-war world was one in which the state and the private sector operated powerfully in tandem, supported by a greatly revised monetary architecture.

As we have stressed, Keynes was concerned mainly with the effective operation of the private economy.

3.   The inflation of the 1970s as “the fault of Keynesian policies”

The inflation of the 1970s began just after the Keynesian post-war mechanisms for the regulation of finance started to be dismantled. In Britain, controls on banking and capital mobility were relaxed, and liberalised arrangements were restored, beginning with Competition and Credit Control (1971) (evaluated as “all competition, no control” by most economists). The root cause of the inflation of the 1970s was the massive expansion of the money supply that followed the deregulation of credit control, as both Friedman’s monetarism and Keynes’sGeneral Theory, Ch. 21, predict.

The inflation of the 1970s was not the consequence of Keynes’s policies but of the dismantling of his policies for restraining the finance sector. In the past, the inflationary 1970s would have been understood as a ‘bankers’ ramp’.

4.   Keynes as “advocate of deficit spending”

While the importance of Keynes’s monetary policies is scarcely recognised, even his fiscal policies are severely misrepresented. Most prominent and pernicious of all is the idea that he advocated deficit spending. From his earliest contributions to the debate on fiscal policy, Keynes was concerned to establish how public works expenditure would pay for itself and would constitute a relief rather than a burden to the public finances. As we have shown in ‘The economic consequences of Mr Osborne’,[i] the outcomes of public expenditure policies over the last century vindicate his analysis. It remains a puzzle why even Keynes’s most ardent champions neglect the evidence.

5.   Keynes as “a supporter of wasteful expenditures”

This morning I joined the Guardian’s panel of Martin Kettle, Len McCluskey and Matthew Oakley to give our verdict on today’s GDP numbers:

Ann Pettifor:

“The Chancellor must eat humble pie”

The statisticians, clutching at straws, blamed the victims – the British people – for the measly 0.2% growth in GDP. It turns out we are too fond of holidaying (the royal wedding effect) and basking in “warm weather”.

But this cannot explain the fall in manufacturing by 0.3% and the 3.2% fall in electricity, gas and water supply. Nor does it explain the rise by 0.7% in “business services and finance”. The fact is the economy remains unbalanced, and the coalition government is doing very little to restore some balance, and with it the potential for recovery.

And without economic recovery, there can be little hope for the public finances. The fact is, the chancellor cannot cut the deficit if the economy does not recover. Today’s numbers offer little succour. GDP is still lower than it was in 2006 – four years after the crisis “debtonated” in August 2007.

The chancellor’s budgetary outcome depends on the plans of the entire economic system and its reactions to the Treasury’s policies. Right now the British economy is responding to the government’s determination not to provide a stimulus to the very weak private sector – by faltering.

The argument is that Britain “cannot afford” a fiscal stimulus. That we “cannot afford” to boost the private and public sectors, create jobs, generate income and restore hope to 2.5 million unemployed people.

But we could, apparently, afford to bail out the banking system.

The coalition government’s determination not to stimulate the creation of employment, and with it the income that will generate recovery – will be viewed negatively not just by the powerful rating agencies, but by the British people too.

The fact is that just as work makes things affordable for individuals, so employment makes recovery affordable for the economy as a whole. And until the chancellor eats humble pie, and absorbs this economic lesson, neither the economy, nor the public finances will recover.

Martin Kettle:

“The chancellor is a weakened figure”

The longer the British economy continues to show no real signs of growth, the weaker George Osborne’s political stock looks. So aQ2 growth figure of 0.2% is clearly bad news for the chancellor’s authority. It could, of course, have been worse, and it very nearly was. A little growth is disproportionately better than no growth at all. But the fact is that growth has fallen over the quarter and has only risen by the same tiny amount of 0.2% since the spending review in the autumn. Osborne will still blame Labour for this underlying weakness, but the passage of time gradually weakens that argument, while Labour can point to the fact that growth was rising when Alastair Darling handed over in May 2010.

This figure puts a lot of pressure on the economy’s ability to reach the 1.7% annual growth forecast over the next six months, and this in turn increases pressure on Osborne to respond with new measures. No chancellor likes to be in this position at any time, and Osborne is particularly at risk from the economy’s negligible pick-up, since his whole strategy is based on the argument that strict fiscal disciplines will aid growth, of which there is no evidence so far. Yet Osborne cannot easily take any of the quick-fix measures – like cutting taxes or interest rates – either. The chancellor is a weakened figure now and his enemies and rivals will scent opportunities.

• Martin Kettle is associate editor of the Guardian

Len McCluskey:

“The price we pay for neo-liberalism”

Set alongside Britain’s moribund economy, Monty Python’s parrot would look like Usain Bolt. The growth figures show our country still stuck in nought-point-something land while other European states, most notably Germany, power ahead.

There are three related reasons for this.

Most immediately, the government’s exclusive reliance on savage public spending cuts are sucking the air out of the economy and depressing demand when a stimulus is clearly needed.

Second, we have allowed our manufacturing base to shrivel while relying over-much on a bloated and now semi-bankrupt financial services sector, for which “growth” still mainly means bigger bonuses. The axe currently hanging over Britain’s last train-building plant in Derby suggests that little has changed in official thinking here.

Third, there is no plan for growth beyond an entirely dogmatic trust in the private sector. The possibilities of, for example, using the state’s stake in major banks to drive investment are simply ignored.

Today’s figures are the price we pay for having a government trying to tackle the crisis of neo-liberal economics with essentially neo-liberal tools. The new thinking needed to build a vibrant 21st century economy which delivers for everyone, not just the elite, most likely requires a new government.

• Len McCluskey is general secretary of Unite

Matthew Oakley:

“It’s about sticking to plan A”

This relatively gloomy GDP data is not unexpected and should not be a cause for panic. However, it does underline that the government needs a more coherent and ambitious approach to growth. This would not mean spending more: the government must stick to its budgetary plans. Not doing so would see us return to an approach based on borrowing and government spending, which we have seen to be unsustainable. Instead it must undertake fundamental reform that focuses on the long term.

Policy Exchange will soon be publishing a report outlining how a new pro-growth approach to planning and urban development could stop central and local government control constricting the growth of our cities and towns, and hindering business development. To back this up, the UK also needs to accelerate reform to its welfare system and to transform transport infrastructure investment to bring in more private sector involvement and improve our creaking networks.

Finally, a clearer approach to industrial policy is needed. This is not about picking winners but about being clear on where growth comes from and where the UK has a comparative advantage. It is then about ensuring that structural reform facilitates growth in these areas and encourages seed funding for innovative businesses, while encouraging robust competition.

Reform in each of these areas would not be about snap decisions based on one or two poor quarters of growth, nor would it be about making headlines with policies that sound good but deliver little. It is about sticking to plan A and backing that up with a greater focus on structural reform that allows the UK to grow now and in the future.

• Matthew Oakley is head of enterprise, growth and social policy at Policy Exchange

Below is a short paper I wrote as part of work with Sir David King and the Smith School of Enterprise and the Environment:

“We are capable of shutting off the sun and the stars because they do not pay a dividend. London is one of the richest cities in the history of civilization, but it cannot “afford” the highest standards of achievement of which its own living citizens are capable, because they do not “pay.”

If I had the power to-day, I should most deliberately set out to endow our capital cities with all the appurtenances of art and civilization on the highest standards of which the citizens of each were individually capable, convinced that what I could create, I could afford….

John Maynard Keynes. “National Self-Sufficiency,” The Yale Review, Vol. 22, no. 4 (June 1933), pp. 755-769.

UNEP’s latest publication, Towards a Green Economy tackles the vexed question of financing the Green Transition and estimates that

“to halve CO2  emissions by 2050, requires investments of approximately US$ 750 billion per year from 2010 to 2030 and US$1.6 trillion per year from 2030 to 2050. The World Economic Forum and Bloomberg New Energy Finance, on the other hand, calculate that clean energy investment needs to rise to US$ 500 billion per year by 2020 to restrict global warming to less than 2ºC, while HSBC estimates that transition to a low-carbon energy market will require US$ 10 trillion between 2010 and 2020.” (Towards a Green Economy, page 33.)

The Green Economy team at UNEP make their assessment based on achievement both of the above carbon emissions target, but also the Millennium Development Goals, and estimate a range of US$1.05 trillion to US$2.59 trillion annually.

“On average, these additional investments amounted to 2% of global GDP per year over 2010-2050, across a range of sectors to build capacity, adopt new technologies and management techniques, and scale up green infrastructure.”

The report then proposes a range of potential ways of financing these investments. The UNEP team look to “institutional investors such as pension funds and insurance companies”; to “public financing” by which no doubt is meant taxation and government borrowing from capital markets; to global development institutions (e.g. the IMF, World Bank and other multilateral institutions); and finally to “stable and resilient capital markets.”

In this short paper I want to argue that the financing of a ‘Green Transition’ is affordable, and need not be drawn down from what can broadly be defined as ‘savings’: namely the share of income not consumed by individuals, households, firms, governments and global institutions, and instead ‘saved’ as taxation, capital, pension funds, and reserves.

Instead the financing of a Green Transition should be undertaken in much the same way as e.g. the financing of the Industrial Revolution, the Second World War, and the recent 2007-9 Bank Bailout: by the banking system’s creation of credit at low, sustainable rates of interest. This financing must then be used for investment in productive activity that substantially lowers emissions, facilitates the transition to a de-carbonised economy, and generates the income to repay the public and private banking system’s loans.

The annual sums required for the Green Transition are not excessive, when compared, for example to the intervention undertaken to support the banks in the UK, US and euro-area during the financial crisis. According to the Bank of England’s 2008-9 Financial Stability Report (June 2009, Issue No. 25)

“overall, the total value of actual and contingent support in North America and Europe rose to over US$14 trillion, equivalent to about 50% of annual GDP.”

UNEP’s requirement of 2% of GDP  for financing the Green Transition is modest by comparison to the financing made available by central banks to the private banking sector, and indirectly to governments (through the purchases of bonds/gilts) in 2009.

Savings not needed to finance the Green Transition

In this short note I want to re-state facts known to economists down the ages, but most clearly explained by Keynes, and then subsequently lost to the field of macroeconomics.

The nature of money is highly peculiar. It is very different from the point of view of an individual and from the point of view of the system as a whole. Individuals cannot magic money from nothing. But the banking system as a whole can magic money from nothing.

This money can be used to bring economic activity into existence. Credit creates savings/deposits. Economic activity generates saving, it is not constrained by saving.

Keynes’s predecessors, the Classical economists saw things differently.  According to Classical theory, saving was necessary prior to investment. Money – deposits or savings – existed only as the result of economic activity. These savings (or vaults of silver/gold) then created economic activity.

Keynes’s great contribution was to demonstrate the contrary: that saving, which is another word for non-consumption, or delayed consumption, is not necessary prior to investment. In other words, if a bank promises credit for an investment it really disposes of something belonging to the future: the coming saving. Credit creates deposits and savings. Credit creates economic activity.

Victorian constraints on finance

The economic theory that saving was necessary prior to investment came about, in part, because banks at that time were not adequate to the demands of rapid industrialisation, and firms could not easily raise funds for large-scale investment. Instead they relied on the savings of individuals. The saving habits of the time were therefore incorporated into Classical or Victorian economics and persist to this day in neo-classical economic theory – still dominant in our universities and think-tanks.

For the Victorians, banks were merely channels, passing money from lenders to borrowers; from individuals to firms and governments.[i] But as the banking system evolved, banks were able to create credit in excess of savings.  With time it became clear that neither savings, nor prudent savers were necessary or essential for investment.  Once society accepted banking systems and bank money, money was no longer a scarce resource.  Economic activity was, and is, no longer bound up with, and dependent on the few with savings in excess of income.

Investment was, and is no longer constrained by saving.

Today, to make loans, banks (both central banks and private banks) do not have “savings” or “deposits” – either theirs, or those of others – to extend to others as credit, and on which they charge interest.  The money for a bank loan does not exist, until the borrowers apply for credit. (The myth of ‘fractional reserve banking’ is just that: a myth.) Central banks do not need to tax the population, or to mobilise savings, before the creation of what is today known as ‘Quantitative Easing’, but was in the past known as ‘Money Market Operations’ etc.  

At the height of the financial crisis, Governor Ben Bernanke was asked where he had found $160 billion to bail out an insurance company, AIG. Had he raised the funds from taxation? No, he replied:

“It’s not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank.”

“So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.” (CBS 60 Minutes Show 15 March 2009).

In today’s economy, there is no tangible quantity corresponding to the aggregate of bank money in an economy at any point in time. Such a tangible quantity/quality is not a necessary characteristic of money. The acceptability and hence validity of bank money is due to its being able to facilitate transactions. ^[ii] To enable society, in Keynes’s terms, to ‘afford that which we can create’.

For investors that operate in today’s monetary economies, the relevant consideration is the availability of finance, not savings, and there need be no constraint on finance – because credit is not a commodity and there need be no limit to its creation.

This makes credit both a powerful resource for human development and protection of the ecosystem; but also a dangerous power if unchecked and governed by ‘light-touch regulation’.  If more credit is created by the banking system than there is potential for economic activity, then the outcome is inflation. If less credit is created than there is potential for economic activity, then the outcome is deflation. Furthermore, if loans are made at rates of interest above a sustainable rate of return, the loans become unpayable.

Supply and the price of money

Fortunately, bank money has a second great advantage, the very thing that had motivated its invention: lower interest rates. Public banks could increase the supply of money, and thereby lower its price: the rate of interest. Entrepreneurs were no longer ‘in hock’ to those with savings in excess of income, who were often usurers.

For unlike gold or oil, credit is not subject to the laws of supply and demand. And because it is not subject to the laws of supply and demand, its price – or the rate of interest – should always be low, and is necessarily a social construct. In other words, the price of credit is influenced not by shortages or gluts, but above all by committees of men and women, based in central banks, and in the private banking system, who determine the most appropriate rates of interest for the economy, or for the private banking sector. (Consideration is not, so far, given to the ecological sustainability of rates.) The 2009 creation of extraordinary levels of ‘support’ – $16 trillion – for the banking system was accompanied by decisions by central bank committees to push base or policy rates to the lowest levels in history. While rates across the spectrum did fall, central banks have unfortunately lost control over rates set by the private sector, now determined overwhelmingly by the British Bankers Association’s determination of the London Interbank Offer Rate (LIBOR).

Bank money was a remarkable and very welcome development; a great public good. Indeed capitalism owes much of its advance to the development of sound banking systems.

Using the banking system to facilitate the Green Transition

By increasing the amount of credit in circulation, bank money facilitated what we have come to regard as progress.  The development of modern technology (the light bulb and the steam engine) would not have taken place if entrepreneurs had not had their research and development funded by low-cost finance made available by bank money. Trade was made possible with bank money. The welfare state was made possible by bank money.  And financial crises have been ameliorated by the issuance of bank money.

The 2009 financial crisis demonstrated to the public that the relevant consideration is the availability of finance, in the form of Quantitative Easing, not savings, and there need be no constraint on finance. Society now needs to argue that just as there was no constraint on the financing of the 2009 bailout, so there need be no constraint on the financing of the Green Transition. Instead there must be careful regulation of that financing, and of the rate of interest attached to loans for investment in the de-carbonisation of the economy.

The financing and investment of 2% of global GDP in the Green Transition will in turn generate economic activity, and with it the deposits and savings needed to repay lending. There will be no need to resort to taxation, pension funds or other sources of ‘saving’. Indeed sound economic activity will generate additional savings for individuals, firms and governments.

[i] The US’s Treasury Secretary Tim Geithner believes that banks are merely channels. In testimony to Congress in September, 2009 he said: “Stripped of its complexities, the purpose of a financial system is to let those who want to save -whether for vacation, retirement or a rainy day -save. It is to let those who want to borrow -whether to buy a house or build a business –borrow. And it is to use our banks and other financial institutions to bring savers’ funds and borrowers’ needs together and carefully manage the risks involved in transfers between them.”   Financial Services Committee, Congress, 23 September, 2009.

At the end of last month I delivered the prestigious EBOR lecture at York. My address was entitled:

“Credit, usury and political power: chasing the moneylenders from the temple that is our democracy”

Click on the link below to read a PDF version of the full lecture:

EBOR Lecture November 25th (PDF)

Dan Roberts has a great column in the Guardian today. He asks the right questions. First, why is the Treasury spending £8 billion of taxpayers money reinflating the housing market? Second, why is the Treasury encouraging this now nationalised bank to increase mortgage lending, when the productive sector of the economy – companies, small businesses et al – are being starved of loans from taxpayer-bailed-out-banks, or else having to borrow at usurious rates?

A superb report from the Centre for Research on Socio Cultural Change at Manchester  (“An alternative report on UK banking reform”) suggests the answer: The nationalisation of Northern Rock is being treated as an “equity style turn around”, with the overarching objective of protecting and creating value for the taxpayer as shareholder.

“It is not clear whether the banks have been nationalised or the Treasury has been privatised as a new kind of investment fund.”

It makes perfect sense doesn’t it, given that the Treasury is advised on these matters (some would say it has been captured) almost exclusively by bankers? Get reading the CRESC report -its excellent -  the first piece of independent, academic thinking on reform of the banking sector to have crossed my path.

Article Published in the Times, September 1st 2009. Photo by Jon Enoch.

Ann Pettifor predicted a painful end to the good times. Now she says that only radical action can prevent further gloom

Phil Thornton

Ann Pettifor is a member of a select club — the seers who saw it all coming. Now the economist, who predicted the credit crunch as far back as 2003, believes that the worst is yet to come unless there is radical reform of the financial system.

Six years ago she parodied the International Monetary Fund’s annual economic forecast with her own — The Real World Economic Outlook. Then, in 2006, her book The Coming First World Debt Crisis, warned that rich countries were heading for a debt crisis that would overshadow anything seen in the developing world. Both were ridiculed.

With the British and world economies languishing in the worst recession since the Great Depression and with once-mighty banks reliant on government life support, she could be forgiven for being a little smug. Not a bit of it: “No, being Cassandra is not something I wish for. I hate this role of being a gloomer and doomer, as I’m an optimist by nature. But I am very pessimistic now.”

She is dismayed that politicians have failed to seize the opportunity that the crisis has given them to embark on tough reform of the banking system. Stock markets have rebounded and house prices have stopped falling, but Ms Pettifor fears that politicians and households have started to relax prematurely.

“The economy is no longer in freefall and, as a result, there’s an enormous amount of complacency from politicians, in particular, about what will happen next. I believe politicians have given away the opportunity to restructure the banks and reconfigure the system.”

She likens Alistair Darling, the Chancellor of the Exchequer, to a high-wire artist. “He thinks that if he can just keep his eyes closed he will get to the other side. Yet underneath him is this vast debt that has not been cleared off the banks’ balance sheets. Many of the banks are still insolvent and this has not been addressed.”

Ms Pettifor, executive director of Advocacy International, which advises countries on debt management, made her name spearheading the Jubilee 2000 campaign to cancel the debts owed by the poorest countries. She believes that there are only three solutions to Britain’s woes: write off these debts as unpayable; convert the debt into equity; or use the benefits system to raise people’s incomes so that they can meet their debts.

She is baffled that the Government has used billions of pounds of public money to rescue the banks without insisting on any change in behaviour.

She highlights an admission by the Treasury that one company in three is paying interest rates more than nine percentage points above the base rate and is furious that banks such as Barclays feel able to offer bonuses reminiscent of the pre-crash boom. If the banks do not change their ways, she says, the Government must simply withdraw the insurance guarantees that have kept them alive.

Instead, public money should be used to bail out households and businesses threatened by bankruptcy. “The banks are not using the money productively, yet what we need is for the Government to spend more productively,” she says. “But now there is a consensus that governments should not spend any more in this crisis. That will tip us into a big depression.”

Ms Pettifor, who is a fellow at the New Economics Foundation, a left-leaning think-tank, believes that it is not too late for politicians, regulators and even bankers themselves to embrace reforms that will prevent another cycle of boom and bust. She believes that a culture of easy but expensive credit, which she blames for the accumulation of unaffordable debts over the last two decades, should be replaced with a model of “tight but cheap credit”.

“Orthodox economists talk about cheap money being the cause of the crash. But it was not cheap — subprime homeowners were paying 19 per cent interest. It was easy money that was the cause.” This, in turn, led to the massive inflation in property prices — house prices trebled between 1997 and 2007. “We over-borrowed against these inflated prices. The rollicking times were rollicking and now we are getting a bollocking.”

She was baffled by a recent letter to the Queen — from other leading UK economists — after she reputedly asked why nobody had seen the crisis coming. With a voice bordering on incredulity, she reads out a passage where the letter-writers say “inflation remained low and created no warning sign of an economy that was overheating”.

“What about asset price inflation? We repressed prices and wages but turned a blind eye to assets,” she says, adding that central bankers must monitor asset prices in the same way that they track high street costs.

But how do we achieve cheap but tight credit? In terms of tighter lending standards, it means an enhanced role for bank managers. “When I and my partner took out a mortgage in 1970s we had to see the bank manager, who went through our finances with a fine-tooth comb,” she recalls. “That’s all you need — more bank managers making an assessment of risk.”

Since she believes that high interest rates were a key cause of the crash, she says that low interest rates for loans are essential.

Her prescription for achieving cheap credit is more radical — nationalise the setting of the London Interbank Offered Rate (Libor), which tracks the rates at which the largest banks are borrowing money from each other and is used to set mortgage and business loan rates.

She says that government intervention to keep real rates at a level at which businesses can make a profit would help to stem the rise in insolvencies that, in turn, leads to people losing their jobs and their homes.

This taps into Ms Pettifor’s long-standing worry over the “financialisation” of the economy that has allowed banks to become the “masters, not the servants” of industry at the expense of genuine entrepreneurial activity.

Future lending should be directed towards sustainable home ownership and business activity, rather than speculation.

At times her model comes close to a form of Sharia, the Muslim financial code that forbids the earning of interest. Indeed, in her 2006 book, Ms Pettifor urged society to return to the traditional religious approaches to usury as a way of curbing the excesses of capital market speculation.

The final element of her vision is a “green new deal” to create economic growth and the jobs needed to fill the “crater” of lost employment and output caused by the crash.

Ms Pettifor would take a leaf out of the Bank of England’s book on quantitative easing but would direct new money to the Government to support green projects.

Private banks could lend to the Government at low interest rates for the same effect. “The fact is that when the Government spends, the private sector is the biggest beneficiary. If the Government announces a home insulation programme, it will be the construction industry that will do it,” Ms Pettifor says.

Her forecasts of a crash have been proved right, but will her latest warnings receive a better hearing? She admits that none of the three main political parties is likely to adopt her policy prescriptions. “There is a weakness in being too far ahead of the game.”

Originally published in The Times, September 1st, 2009.

by Ann Pettifor, 8 March, 2009. There is much confusion about the meaning and impact of QE. This is an attempt to summarise what it means, what it does not mean, and how it can be effective in preventing insolvencies by lowering interest rates.

I am indebted to Graham Turner of GFC Economics for sharing his knowledge and experience of Japan’s use of QE with me. Graham spent time in Japan during the years of that country’s Credit Crunch which began in 1990, and is also knowledgeable about the 1930s when QE was adopted by policy-makers.  Japan adopted QE eleven years too late – in 2001, but has since then kept interest rates below 2%.

Graham notes that Ben Bernanke’s book “Essays on the Great Depression” ‘contains no reference to Quantitative Easing…there is astonishingly little analysis of the monetary policy response that secured recovery (in the 1930s) in any of Mr. Bernanke’s essays.’

First lets remind ourselves that a bond is like a loan. The issuer is the borrower, the bond holder is the lender.  So when I buy a bond from the Federal Reserve or BoE, the governors of these banks are issuing a bond (‘I promise to repay on this date…at this rate…’) and I am trusting their word with my money. Bonds, like loans, usually have a fixed term, or maturity. The interest rate on the bond is known as the ‘coupon’, and is what the issuer pays to the bond holders.

Rates on company or corporate bonds are important because they determine whether companies can afford to borrow to invest, to pay wages or to manage cash flow. They determine whether entrepreneurs can take risks – and invest, e.g. in green technology.  If they can’t do any of these things they declare bankruptcy, and lay off their employees.

Above all interest rates determine whether companies can afford to repay the huge debts dumped on them by lenders, so-called ‘private equity’ companies and other financial institutions during the inflation of the credit bubble.

Interest rates on government and corporate bonds can be lowered by QE – purchases of government bonds by central banks and the shifting of these bonds out of the market, and on to the balance sheets of central banks.

The first myth to dispel is that interest rates are currently low. Base rates may be low, but the rates that companies pay, as Warren Buffett has argued is at ‘record levels’.  He tells shareholders that “highly-rated companies, such as Berkshire, are experiencing borrowing costs that, in relation to Treasury rates, are at record levels.  Though Berkshire’s credit is pristine – one of only seven AAA corporations in the country – (its) cost of borrowing is now far higher than competitors with shaky balance sheets but government backing.”

Graham Turner shows that ‘average yields on loans for non-investment grade companies in the UK rose to 31.66% on the 4th March, 2009.’ These are bankrupting rates.

The second myth to dispel is that QE is about ‘printing money’. QE is not about directly using liquidity  injections to boost the supply of money. As we have learned to our cost, plenty of liquidity has been injected into banks, but this has not slowed the pace of bankruptcies. As Turner notes: ‘money supply (M) is entirely endogenous, and depends on the structure of borrowing costs being secured through bond purchases. ‘  It will be vital for the Bank of England to set a long term interest rate target, and to use the purchase of government gilts to reach that long-term, and low target.

QE is about preventing debtors from defaulting. This is done by the Central Banks targeting lower rates of interest e.g. for 30-year bonds (or loans), and achieving this by purchasing government bonds and taking them on to their balance sheets, (It can be used to purchase corporate bonds, but is more effective in bringing down all rates, if used to purchase government bonds.)

These purchases are known as ‘open market purchases’.  By purchasing government bonds,  central banks increase the price of the bonds, but damp down the yields, or rates of interest, on these bonds. It is particularly important that rates on e.g. 20-year bonds should be driven down low.

Within a month of the Federal Reserve starting large scale open market purchases of government bonds in April, 1932,  corporate bond yields had started to fall decisively.

By buying up government bonds, the Federal Reserve or the Bank of England will increase the price of government bonds, and lower the yield – effectively the interest rate on these bonds. By lowering the rate on government bonds, central banks will help suppress rates across the board.

By lowering rates, they will begin to help companies, and stop the spread of insolvencies – the economic ‘virus’ at the heart of the crisis.

Two additional points: QE has to be applied early on in the crisis. If insolvencies are allowed to spread and engulf the whole economy, there comes a point when QE just cannot help. Second, in a highly synchronised, global economy, it is vital that central banks co-ordinate and co-operate to apply QE across the board. If applied in just one or two economies, the measure will not work. If it is not applied in the United States soon, then US insolvencies will cause unemployment to spiral higher, and will exacerbate global economic failure.

So the stakes are high, and the timing of QE measures vital.

Yesterday’s dramatic Bank of England 1.5% rate cut was an extraordinary admission of analytical failure. The Monetary Policy Committee of orthodox economists (with Danny Blanchflower the honourable exception) is well behind the curve. While it is tiresome to beat one’s own drum, I am obliged to point out that on the 12th July I wrote a short piece for the Guardian beseeching the Bank of England not to “sacrifice the economy on the cross of inflation targeting”. Today’s numbers from the Insolvency Service reveal that more than 4,000 companies have been sacrificed.  Company insolvencies have risen by 26.3% over a year ago, and by 10% over the last quarter. This represents the loss of a great deal of productive activity, and of thousands of jobs.

I do not have an army of economists undertaking research for me. Nor do I have the ample resources enjoyed by the Bank of England and the Treasury. And yet common sense, a cursory review of the direction of commodity prices, as well as a refusal to play the game of baiting workers demanding pay rises with threats of non-existent inflation – made the progress of prices perfectly clear.  Inflation rises in the Spring were not caused by wage demands, but instead by a spike in internationally-fixed commodity prices. The coming financial meltdown was soon going to dampen demand for oil and other commodities, and force those prices down again. In the meantime high oil and commodity prices were exacerbated by high real rates of interest. The combination was threatening the solvency of companies, households and individuals.That much was obvious to me. Why was it not obvious to the Bank of England and the Treasury?

But perhaps the most disturbing aspect of yesterday’s rate cut was the fact that it may not have any real impact on other rates within the economy. Private and nationalised banks are cocking a snoop at both the Bank of England and the Treasury, and both appear impotent. This is worrying. When governments appear to lose control over the economy, people look elsewhere for leaders that will exercise some control over the economic forces that impact so detrimentally on their lives and livelihoods.

The Bank of England and the Treasury’s ideological fixations and fetishes continue to worsen this crisis. Is yesterday’s dramatic rate cut a sign that Old Lady of Threadneedle St. might be catching up?  For the sake of us all, I sincerely hope so. But I fear it may be too late.